Editor's note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.
In most important ways, the Thrift Savings Plan, or TSP, a retirement savings plan for government workers and the largest defined-contribution plan in the world, is a model for other workplace retirement plans.
First and foremost, it features a utilitarian menu of ultralow-cost index funds as well as target-date funds (“Lifecycle,” or “L” funds) composed of those index funds. BlackRock manages the funds. The TSP menu also includes a ringer: the G fund, which is available only to TSP participants. I’ve described “G” as kind of a unicorn, in that it guarantees its investors’ principal but features a higher return than cash. The closest analog is probably stable-value funds, which use insurance contracts to maintain stable net asset values but aren’t technically guaranteed.
The TSP has another quality I like to see in a company retirement plan: The menu changes very infrequently. To the extent that the board overseeing the TSP alters the lineup, those changes are invariably well considered and clearly communicated in advance.
That said, the TSP is currently planning a few more changes to the lineup than usual, largely designed to bring the plan’s offerings more in line with other large defined-contribution plans. On the one hand it's reassuring that those changes are happening very gradually. On the other, the slow pace means that the TSP still has a few idiosyncratic characteristics that participants should be aware of if their aim is to build a well-rounded retirement plan.
Lifestyle Funds Getting a Needed Overhaul The big changes on the horizon largely relate to the firm's L, or Lifecycle funds, which are the default options for participants who don't make any investment selections. These alterations will affect the number of L funds, as well as the allocations within them. Currently the TSP offers L funds in 10-year increments (L 2020, L 2030, and so on). But the TSP is expected to launch L 2025, L 2035, L 2045, L 2055, L 2060, and L 2065 funds this summer.
An additional change, which Morningstar director of policy research Aron Szapiro addressed last year, is to make the asset allocations of the L funds more aggressive and stock-heavy than was the case before. The funds geared toward the youngest investors--the L 2060 and L 2065 funds set to launch this summer--will feature a new, more-aggressive glide path. Those funds will start with 99% of their holdings in equities, up from the 90% for the youngest L fund investors in the past. At the other end of the age spectrum, the TSP will also make changes to the asset allocations of the L funds for people in retirement: The equity allocation of the L Income fund will gradually rise from 20% to 30% over a 10-year period. (It was about 22% as of April 2020.) For the funds in between, the equity allocations will not increase, but they will be frozen until they eventually come in line with the glide path planned for the newest L funds. (Because the funds would normally reduce their equity allocations over time, the act of “freezing” the equity allocation will translate into a more aggressive glide path than they would otherwise have.)
Finally, in another step to bring the L funds more in line with target-date fund industry best practices, the L funds have increased their allocations to foreign stocks as a percentage of their equity portfolios, from 30% to 35%. That change has already taken effect and is reflected in their April asset allocations.
These changes are all overdue. The target-date fund industry has increasingly gravitated to offering target-date funds in five-year increments to ensure that their asset allocations more closely align with participants’ anticipated retirement dates. Given the size of the TSP and the number of participants affected, offering a more granular lineup of funds in five-year increments seems like an obvious step.
The adjustments to the glide path also appear well reasoned, particularly because the L funds’ previous allocations put them quite out of sync with other target-date funds with the same retirement dates. Indeed, the L funds still are still somewhat conservative relative to target-date funds geared toward investors in that same age band. For example, L 2040 staked about 72% of its assets in stocks as of April 2020, whereas the typical 2040 target-date fund in Morningstar’s database had 5 percentage points more in equities. The equity-light posture is even more pronounced for the near-dated L funds. L 2020, for example, has just 23% of its assets in stocks, whereas the average 2020 target-date fund has 42%.
Those lighter equity weightings help to smooth volatility a bit and were arguably welcome during the recent market downturn. But Morningstar data show that target-date fund participants do a good job of buying and holding tight through periods of market volatility. Moreover, TSP participants may also be covered by pensions. Having a higher baseline of guaranteed retirement income than many other workers have should, all else being equal, allow TSP participants to shoulder more equity risk, not less.
I Fund Changes More Contentious While the changes to the L funds are underway, another prospective change to the TSP menu is proving more contentious: adding emerging markets to the international, or I, fund. Based on the recommendations of consultants, the board overseeing the TSP had planned to change the I fund's benchmark from the MSCI EAFE Index, which focuses exclusively on developed-markets stocks, to the MSCI All Country World ex-U.S. Investable Market, a broader index that includes emerging markets.
In many ways this seems like an obvious adjustment and would bring the TSP in line with more sophisticated 401(k) menus. (In previous discussions of the TSP, I've always mentioned the lack of emerging-markets exposure as a notable hole in an otherwise well-diversified lineup.) But the move has recently gotten pushback by some members of Congress as well as the White House, which argue that the new index's exposure to Chinese stocks exposes TSP participants to outsize risks. (Chinese stocks compose about 11% of the MSCI All Country World ex-U.S. index.) However, the Federal Retirement Thrift Investment Board has indicated that it intends to go ahead with the benchmark switch in the second half of 2020.
Where Things Stand The omission of emerging markets is by no means a deal-breaker for federal employees who otherwise have a superb lineup in the TSP. Indeed, over the past decade MSCI EAFE trackers have generally outperformed foreign-stock index funds that include emerging markets, and the MSCI EAFE index's volatility profile has been lower as well. Nonetheless, it's one of a few idiosyncrasies that TSP participants should be aware of.
The TSP’s fixed-income lineup is another. That’s because it downplays certain bond types that investors might want to be part of their portfolios. The F fund tracks the Bloomberg Barclays Aggregate Index so there's no exposure to Treasury Inflation-Protected Securities or high-yield bonds, for example.
Moreover, the combination of the G fund and the F fund, which tracks the Barclays U.S. Aggregate Bond Index, gives TSP investors a heavy emphasis on U.S. government bonds. That’s obviously a disadvantage in environments when credit-sensitive bonds have outperformed—in 2019, for example. On the plus side, both G and F funds have provided strong protection in equity-market sell-offs, as in the first quarter of 2020.
Indeed, a number of characteristics have historically provided TSP participants with a fairly smooth ride: the emphasis on quality in the fixed-income portfolio, the exclusion of emerging markets in the international fund, and the equity-light posture of the L funds. That conservative positioning isn't without merit, but is arguably overdone given what the data say about 401(k) participant inertia. During the first-quarter market rout, for example, just 5.6% of 401(k) participants in a Morningstar study made any changes to their portfolios' asset allocations, and just 2.4% of target-date fund owners in 401(k) plans did so.